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Absorption & External


Purnima Satija
Assistant Professor
PCTE Group of Institutes
Plan of Study
Introduction to Reconstruction

Meaning of Amalgamation

Features of Amalgamation

Objectives of Amalgamation

Types of Amalgamation

Purchase Consideration

Methods of calculating purchase consideration 2


Accounting entries in the books of Transferor Companies

Accounting entries in the books of transferee companies

Preparation of Balance Sheet

Treatment of inter-company owings and unrealized profit in stock


When a company is suffering loss for several past years and
suffering from financial difficulties

When a company's balance sheet shows huge accumulated

losses, heavy fictitious and intangible assets or is in financial

Such a company faces the danger of going onto liquidation

either voluntarily or because of a petition by any of its creditors
or Debenture holders.



Internal Reconstruction External Reconstruction

Internal Reconstruction is an It is the arrangement whereby

arrangement made by an existing company is
companies whereby the formed to take over the
claims of shareholders, business of an existing
Debenture holders, creditors company and existing
and other liabilities are company goes into
altered/reduced, so that the liquidation and the new
accumulated losses are company purchases its
written off, assets are valued business.
at its fair value and the
balance sheet shows the true
and fair view of the financial
position. 6
Amalgamation and Absorption

In general, "Amalgamation is a union of two or more

companies, made with an intention to form a new company."

In terms of finance, "Amalgamation is an agreement (deal)

between two or more companies to consolidate (strengthen) their
business activities by establishing a new company having a
separate legal existence.

The term absorption is used when an existing companies takes

over the business of one or more existing companies.

In India, accounting problems regarding amalgamations are dealt

with in accordance with the Accounting Standard (AS) - 14
issued by the Institute of Chartered Accountants of India (ICAI).

In India, Amalgamation is used in the same sense as Business

Combination is used in the USA.

AS-14 is effective since the accounting period beginning on or

after 1.4.1995 and is mandatory in nature.

Important Definitions

Amalgamation means an amalgamation pursuant to the

provisions of the Companies Act, 1956 or any other statute
which may be applicable to companies.

Transferor company means the company which is amalgamated

into another company.

Transferee company means the company into which a transferor

company is amalgamated.

Features of Amalgamation

For amalgamation two or more companies are required to

amalgamate themselves.

All the existing companies which are merged are to be


A new company is formed to take over the business of the

companies which are to be merged.

The value of the new company formed is expected to be greater

than the total of independent values of the amalgamating
companies. 11
Objectives of Amalgamation

Diversification To avoid
To reduce cost
& Expansion competition

Increasing Expanding the
market share product line

Maximizing Achieving
financial technological
potential success
Meaning of Amalgamation

When two or more existing companies go into liquidation and

a new company is formed to take over their business , it is
known as amalgamation.

The institute of chartered accountants of India has issued

Accounting Standard 14 (AS 14) on accounting for

This standard specifies the procedure of accounting for

amalgamation and the treatment of any resultant goodwill or

When one or more existing companies go into liquidation and some

existing company buys the business, it is known as absorption.

Generally stronger units takes over weaker units.

The major characteristics of the absorption are as follows

1.There is no formation of any new company.

2.There is an absorption of one or more existing companies by one

existing company.

3.There is only liquidation of absorbed company while the absorbing

company retains its legal entity.
External Reconstruction

In it a new company is formed to purchase the business of an

existing company.

The basic objective is to write off the accumulated losses and

fictitious assets.

The assets and liabilities of the existing company are

transferred to the newly formed company.

X ltd goes into liquidation and a new company Y ltd comes

into existence to take over the business of X ltd, this is the case
of the External Reconstruction.
Types of Amalgamation from accounting
point of view
Amalgamation in the nature of Merger
An amalgamation should be considered in nature of merger if it fulfills
following conditions :

1. All assets & Liabilities of the transferor company become the assets &
liabilities of transferee co. after amalgamation.

2. Shareholders holding not less than 90% of face value of equity share
capital of the transferor company (other than equity shares already
held therein, immediately before the amalgamation, by the transferee
company or its subsidiaries or their nominees) become the equity
shareholders of the transferee by virtue of the amalgamation.
4. The business of transferor company is intended to be carried on, after
the amalgamation by the transferee company.

5.The consideration for amalgamation receivable by those equity

shareholders of the transferor company who agree to become equity
shareholders of the transferee company is discharged by the transferee
company wholly by issue of equity shares in the company, except that cash
may be paid in respect of any fractional shares.
6. No adjustment is intended to be made to the book values of the assets
and liabilities of the transferor company when they are incorporated in the
financial statements of the transferee company except to ensure uniformity
of accounting policies.
Amalgamation in the nature of Purchase

1. An amalgamation in nature of purchase takes place when any one

or more of the conditions specified for the amalgamation in nature
of merger is not satisfied.

2. Under this nature of amalgamation one company acquires another

company and equity shareholders of the combining entities do not
continue to have proportionate share in the equity of the
combined entity or the business of the combined entity is not
intended to be combined after amalgamation.
Purchase Consideration

Purchase Consideration refers to the amount paid by the purchasing

company to the vendor company for the purchase of business.

The purchase consideration for amalgamation includes the shares

and other securities issued and payment made in cash or other assets
by the transferee company to the shareholders of transferor company.

It should not include the amount of liabilities taken over by

transferee company, which will be paid directly by this company.

Accounting Standard-14 defines the term purchase consideration as the

aggregate of the shares and other securities issued and the payment
made in the form of cash and other assets by the transferee company to
the shareholders of the transferor company.

Lump Sum Payment

Methods of Purchase Method

Net Assets Method or Net
Worth Method

Net Payment Method

Share Exchange Method

or Intrinsic Value Method
1. Lump Sum Payment Method

Sometimes, the transferee company agrees to pay a fixed sum

to the transferor company and takes over its business.

In such a case, the amount so agreed upon is called a lump

sum payment of purchase consideration.

For example, a Company ABC ltd purchase the business of the

company XYZ ltd at an agreed price of Rs.10,00,000 in all. Here the
amount of Rs. 10,00,000 is the purchase consideration.
2. Net Assets Method or Net Worth Method
The purchase consideration is calculated by adding the values of
various assets taken over by the transferee company and then
deducting therefrom the values of various liabilities taken over by
the transferee company.

The values of assets and liabilities for the purpose of calculation of

purchase consideration are those that are agreed upon between the
transferor company and the transferee company and not the values at
which they appear in the balance sheet of the transferor company
Important points to be taken into consideration
The term assets will always include cash in hand and cash at bank
unless otherwise stated but shall not include fictitious assets.

The term liabilities will mean all liabilities to third parties. It will
exclude items appearing under Reserves & Surplus as these are
payable to shareholders.

The term Trade Liabilities will include trade creditors and bills
payable and will exclude other liabilities to third parties such as
bank overdraft, outstanding expenses.
The term Business Takeover means that the transferee company
has agreed to take over all the assets of the transferor company and
liabilities to outsiders.

The shares shall be issued in whole number and not in fraction. The
fractional shares must be valued at the market price and shall be
paid in cash.

If any asset or liability is not taken over by the company, it should

not be included in purchase consideration.

A Ltd. Takes over the business of B Ltd. At the following

Fixed Assets- Rs. 3,00,000

Current Assets- Rs. 1,00,000

Debentures- Rs. 50,000

Current Liabilities- Rs. 1,00,000

Calculate the amount of purchase consideration

Liabilities Rs. Assets Rs.
14,000 Equity shares of Rs. 100 14,00,000 Sundry Assets 18,00,000
each fully paid

General Reserve 10,000 Discount on issue of 10,000


10% Debentures 2,00,000 Preliminary Expenses 30,000

Sundry Creditors 2,00,000 P&L a/c 60,000

Bank Overdraft 50,000

Bills Payable 40,000


R Ltd agreed to take over the business of A Ltd. Calculate

purchase consideration under Net Assets Method on the basis
of the following:-
The market value of 75% of the sundry assets is estimated to be
12% more than the book value and that of the remaining 25 % at
8% less than the book value.

The liabilities are taken over at book values.

There is an unrecorded liability of Rs. 25,000

Liabilities Rs. Assets Rs.
50,000 equity shares of Rs. 10 5,00,000 Goodwill 50,000

General Reserve 1,50,000 Plant & Machinery 5,50,000

Profit and Loss Account 3,50,000 Furniture 90,000

Sundry Creditors 1,20,000 Stock 2,50,000
Bills Payable 80,000 Sundry Debtors 1,68,000
Cash at Bank 80,000
Preliminary Expenses 12,000
12,00,00 12,00,000

On 1st Apr, 2002, Y Ltd. Decides to purchase the business of

X Ltd. On the following terms:-
Goodwill of X Ltd. Is to be valued at Rs. 1,00,000.

Value of furniture to be reduced by 20%.

Other assets are to be taken over at their book values.

PC is to be discharged in the form of 1,00,000 fully paid equity

shares of Rs. 10 each and the balance is to be paid in cash.
Liabilities Rs. Assets Rs.
6000 Equity shares of Rs. 10 60,000 Goodwill 28,000

5% Debentures 10,000 Land and Building 16,000

Sundry Creditors 6,000 Plant and Machinery 28,000

General Reserve 4,000 Stock 16,000
P & L Account 20,000 Debtors 8,000
Cash 2,000
Preliminary Expenses 2,000
1,00,000 1,00,000
Company B takes over the business of company A.

B does not take over cash but agrees to assume the liability of
sundry creditors at Rs. 5,000

The value agreed for various assets is :-

Goodwill- Rs. 22,000

Land and Building- Rs. 25,000

Plant and Machinery- Rs. 24,000


Debtors:- Rs.8,000
3. Net Payment Method
Under this method the value of purchase consideration is
ascertained by adding the various payments made by the
transferee company to the shareholders of the transferor

Purchase Consideration under this method is taken as the

aggregate of all payments made in the form of shares,
debentures, other securities and cash to the shareholders of the
transferor company.
Important points to be taken into consideration
1. The assets & liabilities taken over by the transferee co. are not to be

2. Any payment whether in cash or shares made by the transferee co.

for shareholders must be considered.

3. The payments made by the transferee company to discharge the

debenture-holders and other outside liabilities and the cost of
winding up of transferor company shall not be considered as a part
of purchase consideration.

4. No amount of liabilities will be deducted even if it is assumed by

the purchasing company.
Question-4 (Contd)
B Co. agrees to give for every 10 shares in A Ltd. 15 shares of
Rs. 10 each, Rs 8 paid up and balance of the purchase
consideration is paid in cash.

Calculate the amount of purchase consideration


Set Ltd. Takes over the business of Upset Ltd. At the following
The shareholders of Upset Ltd. Are to be paid Rs. 25 in cash and the
offer of 4 equity shares of Rs. 10 each in Set Ltd. For every share of
Upset Ltd. The shares of Upset Ltd. Consists of 5,000 shares.

The debenture-holders holding 5,000 debentures of Rs. 100 each are to

be redeemed at a premium of 10%

Cost of Winding up amounts to Rs. 25,000

Calculate the amount of purchase consideration

A Ltd. agrees to absorb B Ltd., the consideration being::-

The assumption of trade liabilities of Rs. 50,000.

The payment of the costs of liquidation Rs. 2,000.

The redemption of 80% debentures of Rs. 6, 00,000 at a premium of


The payment of Rs. 20 in cash and the exchange of two fully paid
shares in A Ltd. for every share in B Ltd. The share capital of the
vendor company consists of 20,000 shares of Rs. 25 each fully paid.

Calculate the amount of purchase consideration

Liabilities Rs. Assets Rs.
Share Capital 30 Fixed Assets 130
10% of preference Shares of Rs.
100 each
Equity Shares of Rs. 10 each 60 Investments 24

General Reserve 36 Current Assets 20

12% Debentures 28
Current Liabilities 20
174 174
The balance sheet of Dreamers Ltd. As on 31st March, 2013 is

Performers Ltd. Signified their agreement to take over the

assets and liabilities of Dreamers Ltd. As per the following
terms and conditions.
Fixed Assets at 90% of the book value.

Investments at 10% above the par value.

Current Assets and Liabilities at book value except that stock-in-

trade at cost amounting to Rs. 10 lakh was agreed to be taken
over at discount of 20%
12% debentures are to be discharged at a premium of 15% by
issuing 12% debentures of Performers Ltd.

Preference Shareholders are to be discharged at a premium of

15% by issuing 10% preference shares of Rs. 100 each.

The equity shareholders in Dreamers Ltd. Are to be issued 5

equity shares of Rs. 10 each in Performers Ltd. For every 3
shares held by them.

Calculate Purchase Consideration under:-

Net Assets Method

Net Payment Method

How to identify the method of PC?
1. If the problem specifies the method to be adopted adopt the
method specified

2. If the method is not specified in the problem, but the amount

of purchase consideration is given, it is lump sum method and
does not need any calculation

3. When the payments made by purchasing company to vendor

company is given, with the statement Balance in then,
Net Asset Method must be adopted.
4. When the payment made by purchasing company to Vendor
Company is given liability wise or any other item wise without
the statement Balance in.. then, Net Payments Method
must be adopted.
4. Share Exchange Method
Under this method, the purchase consideration is required to be
calculated on the basis of intrinsic value of shares.

Intrinsic value is calculated by dividing the net assets available for

equity shareholders by the number of equity shares.

This value determines the ratio of exchange of the shares between

the transferee and transferor companies.
Liabilities X Ltd. Y Ltd. Assets X Ltd. Y Ltd.
Equity Share Capital: 7,50,000 6,00,000 Fixed 9,75,000 6,25,000
Shares of Rs. 10 Assets
General Reserve 5,00,000 2,00,000 Stock 2,10,000 2,35,000

Profit and Loss 2,50,000 1,00,000 Sundry 2,50,000 2,00,000

Account Debtors
Sundry Creditors 2,10,000 2,40,000 Cash at 3,00,000 1,00,000
Bills Payable 25,000 20,000
17,35,000 11,60,000 17,35,000 11,60,000
X Ltd. Agrees to absorb Y Ltd.

The shareholders of Y Ltd. Are allotted in full satisfaction of

their claims, shares in X Ltd. In the same proportion as the
respective intrinsic values of the shares of the companies bear
to each other.

Calculate the purchase consideration.

Accounting for Amalgamations
Journal Entries in the books of
Transferor Company.
In books of Transferor co.
1. For transferring assets taken over by the transferee company.
Realisation a/c Dr.
To Various assets (individually)(at book value)
Note : Assets on which some provisions has been made are to be
transferred to realisation account at their gross figures and provisions
made should be transferred along with liabilities.

2. For transferring liabilities taken over by the transferee company.

Various liabilities a/c Dr. (at book value)
To Realisation a/c
Note: Only those liabilities are to be transferred which have been assumed
by the transferee co. If there is any fund which partially represents
liability and partially represents undistributed profit, then that portion
which represents liability should be transferred to realisation a/c.
3. For Purchase consideration
Transferee Companys a/c Dr.
To Realisation a/c
4. For receiving PC from the transferee Co.
Bank a/c Dr.
Shares in transferee Co. a/c Dr.
To Transferee Co a/c
5.For assets sold bt the transferor co. not taken over by the
transferee co.
Bank a/c Dr.
Realisation a/c (if loss on sale of assets)Dr.
To Assets a/c
To Realisation a/c (if profit on sale of assets)
6. For Liquidation Expenses
(a) If expenses are to be met by transferor co.
Realisation a/c Dr.
To Bank a/c
(b) If Expenses are to be met by transferee co. there are two alternatives :
First alternative : No entry
Second alternative :
(i) Transferee Co. a/c Dr.
To Bank a/c
(ii) Bank a/c Dr.
To Transferee co.s a/c
7. For liabilities not taken over by the transferee co. when paid by the
transferor co.
Various liabilities a/c Dr.
Realisation a/c (if excess payment is made)
To Bank a/c
To Shares in transferee Co. a/c
To realisation a/c (if less payment is made)
8. For transferring preference share capital
Preference share capital a/c ..Dr.
Realisation a/c(if excess is to paid) ..Dr.
To Preference Shareholders a/c
To Realisation a/c (if less is to be paid)
9. Preference Share Holders ..Dr.
To equity/Preference Shares of transferee co.
10. For closing Realisation a/c
(a) If profit
Realisation a/c ..Dr.
To equity Shareholders a/c
(b) If Loss
Equity shareholders a/c ..Dr
To Realisation a/c
11. For transferring equity share capital and accumulated profit
Equity Share Capital a/c ..Dr.
General reserve a/c ..Dr.
Debenture Redemption Fund a/c..Dr.
Dividend equilisation Reserve a/c ..Dr.
Securities Premium a/c ..Dr.
Profit & Loss a/c ..Dr.
Accident Compensation Fund a/c ..Dr.
(to the extent it does not denote the liability)
Shares Forfeited a/c ..Dr.
Profit Prior to incorporation a/c ..Dr.
Any other reserve or Fund a/c ..Dr
To Equity shareholders a/c
12. For transferring accumulated losses and expenses not writtenoff
Equity shareholders a/c ..Dr.
To Profit & Loss a/c ( Debit balance)
To Discount or exp on issue of shares or debentures a/c
To Preliminary Expenses
To Underwriting commission

13. For paying Shareholders

Equity Shareholders a/c ..Dr.
To Bank or Shares in Transferee co. a/c
Journal Entries in the books of
Transferee Company.

There are two methods of accounting for amalgamation in the

books of transferee company :

1.The pooling of Interest Method

2.The purchase Method

Pooling of Interest Method
The following journal entries are to be passed in books of transferee co.
for incorporating the financial statements of the transferor co:
(1) On amalgamation of business
Business Purchase a/c ..Dr.(with amt of PC)
To Liquidators of Transferee Co. a/c
(2) For recording assets & liabilities taken over
Sundry assets(individually) (Book Value)
To Sundry Liabilities(individually) (Book Value)
To Reserves a/c (Book Value)
To Business Purchase a/c (Book Value)

Note :The difference between debits & credits is adjusted in the reserves
of transferee company.
(3) For making payment to the liquidator of transferor co.
Liquidators of transferor Co. a/c Dr.
To Bank/Share Capital/Security Premium

(4) If Liquidation expenses are paid by the transferee company.

General reserve or Profit & Loss a/c Dr.
To Bank a/c

(5) For formation expenses of the transferee co.

Preliminary Expenses a/c Dr.
To Bank a/c
Purchase Method
The following Journal entries are passed in the books of transferee
company for incorporation of the financial statements of the transferor
(1) For purchase of business from the transferor company :
Business Purchase a/c ..Dr. (For PC)
To Liquidation of transferor co.
(2) For recording assets & liabilities taken over
Various assets a/c ..Dr. (at revised value, if any otherwise
at book value)
To various Liabilities a/c (with figures at which
they are taken over)
To Business Purchase a/c
Note : If credit is more than debit it is debited to Goodwill a/c but if the
debit is more than credit then it is credited to capital reserve a/c.
(3) For making payment to the liquidator of the vendor company :
Liquidators of transferor co. a/c ..Dr
To Bank a/c
To Share Capital a/c
(4) When Statutory Reserve is maintained
Amalgamation adjustment a/c ..Dr
To Statutory Reserve a/c
(5) If liquidation exp are paid by transferee co.
Goodwill a/c ..Dr
To Bank
(6) For Formation exp of transferee co.
Preliminary Expenses a/c ..Dr
To Bank a/c
(7) When goodwill is written off against Capital reserve
Capital reserve a/c ..Dr.
To Goodwill a/c

(8) If any liability is discharged by the transferee company

Respective Liability a/c ..Dr. (with payable amount)
To Share capital/debentures/bank a/c